Poor
infrastructure may lead Indonesia
to
middle-income trap
Nurkholisoh Ibnu Aman ;
An economist at Bank Indonesia (BI), Jakarta
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JAKARTA
POST, 03 Maret 2014
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This
newspaper recently discussed the risk of Indonesia’s economy falling victim
to the so-called “middle-income trap”.
Such a trap occurs when a rapidly growing
economy stagnates at the middle-income level and fails to maintain its growth
momentum to graduate into the ranks of high-income countries.
The concept of a middle-income trap is
backed by empirical evidence. A study by the World Bank in 2011 found that of
101 middle-income countries in 1960, only 13 had become high-income countries
by 2008. Countries in Latin America and the Middle East provide lucid
illustrations. Most economies in these two regions reached middle-income
status as early as the 1960s and have remained there ever since.
What about Indonesia? The same study showed
we initially joined the middle-income group in 1996 but fell back after
experiencing a major crisis in 1997/ 1998. It took us six years to re-join
the league and we have been a middle-income country since then with a per
capita income of US$3,420. The threshold for becoming a middle-income country
is $1,036 and that of a high-income country is $12,616.
Keen
observers of Indonesia’s economy would agree that infrastructure is key to
helping the country leap out of its current middle-income status. Indeed, a
recent study by the International Monetary Fund (IMF) found that the highest
risk exposure to Indonesia — in terms of growth slowdown and middle-income
trap — is transport infrastructure.
People in China, unsurprisingly, have a
wise, old saying about this: “If you want to be rich, you must first build
roads.”
But we
do not need to travel far to realize that our infrastructure is in poor
condition. From traffic gridlock to electricity blackouts to slow Internet
connections, it’s clear that our physical infrastructure has not been able to
support the expanding economy and growing demands of the population. As a
consequence, economic growth has been prevented from achieving its full
potential.
Encouragingly,
there are positive developments, despite the need to speed up progress.
Investing in infrastructure has been a dominant national agenda item in the
past few years.
But on
top of infrastructure, Indonesia needs to invest in three other equally
important things.
First,
the financial system. We need to develop a financial market that enables
funds to be allocated in the most efficient way. This includes elements such
as a well-functioning securities market, a seamless payment system and an
effective legal and regulatory framework.
As in
many other developing economies, our financial system is dominated by banking
institutions and this resulted in the so-called “funding bottleneck”. Banks’
main sources of funds are short-term deposits while the most productive use
of these funds is generally in the form of long-term and risky projects.
Long-term investors, such as pension funds and insurance firms, are yet to be
actively involved in the country’s underdeveloped debt markets.
Indonesia’s debt market is indeed still in
its early stages compared to other economies in Asia. The Jakarta stock
market capitalization, which ranged from 40 percent of gross domestic product
(GDP), also lagged behind its counterparts in the region, such as Thailand
(69 percent), the Philippines (96 percent), or Malaysia (144 percent).
The second piece of investment is related to
institutions. Its importance may not seem as obvious as building toll roads
or installing new power plants. One may relegate such efforts to an
afterthought or, worse, dismiss it altogether.
But it could not be further from the truth.
Numerous studies have shown it is institutional problems, rather than
resource constraints, that at times are the primary reason for failures in
developing economies, including Indonesia. Investors and donor agencies often
find themselves entangled in a web of poor regulations, bad coordination and
a lack of commitment of public institutions to deliver much needed government
services.
Last but
certainly not least, is investment in human capital. An educated workforce is
as critical as having a reliable telephone network to the economy. There is
abundant scientific evidence that confirms the link between investment in
education and higher economic prosperity.
Indonesia has the fourth largest education
system in the world, yet in the most recent Program for International Student
Assessment (PISA) report on 65 nations, Indonesia ranked last. In an era of
knowledge-based economies and amid the global war for talent, it should be a
major concern that our education system is struggling.
In the labor market, our workforce may still
have an edge against its main competitors. Measured by a ratio of real wage
to productivity, laborers in Indonesia are among the most competitive in the
region. However, as we aspire to break into high-income status, we should no
longer rely on cheap labor as a source of competitiveness. In fact, it is a
typical route for a country to get trapped at the middle-income level.
As wages rise, manufacturers will find
themselves unable to compete with lower-cost producers in export markets.
Yet, they still lag behind the advanced economies in producing higher-value
products. This is exactly the case with several countries in Latin America
and the Middle East now “stuck” at the middle-income level.
Qualified
human capital will help our economy switch to a “new growth model” that
emphasizes innovation and increased industrial capability.
In this model, an ecosystem exists where elements such as a diffusion
of technology, research and development, intellectual property rights and
risk capital interact with each other without barriers and form a more
sustainable engine of growth.
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